Has Recent U.S Data Signaled A Bottom?

A wave of new domestic economic data along with an economic stimulus plan has refueled interest in the Materials sector, particularly precious metals and agriculture stocks. Copper, known as “the commodity with a PhD in economics,” has risen over 28% in the past 30 days while the sector as a whole has gained nearly 33% in the same amount of time. While I agree in the long term prospects of many blue-chip commodity holdings, I feel their current prices have outpaced their valuations. U.S. recessionary indicators, specifically employment data and index performance, have convinced me the global economic plummet in growth may have bottomed, but it by no means has signaled a turnaround in the economy and more particularly the Materials sector.

A Brief Recap of the Q1 2009

We started with an acute bounce in the construction materials companies when details of the Obama stimulus package were being finalized, following a dismal quarterly performance by many of the leaders of the Materials sector. Freeport McMoRan (FCX) reported a drop in performance of 500%, due to write downs of goodwill, Dow Chemical (DOW) experienced an 80% drop in earnings, Dupont (DD) reported a 32% drop in earnings, and International Paper (IP) reported a drop of almost 210% in earnings. Surprisingly, Monsanto (MON) was able to report earnings growth of 40%,benefiting from a record 2007/2008 marketing season in agricultural commodities. Monsanto however, seems to be one of the few exceptions within the sector. As earnings season begins and economic data is released, I am convinced the worst may not have past for many of these companies. Since Materials is based widely on the health of the economy, I will start by looking at some of the recessionary indicators that have recently been released.

Important Economic Signals

GDP expectations  have fallen precipitously over the past four quarters. Quarterly change in GDP was expected to be 0.9% in Q1 2008, but has since contracted 6.3% in the Q4 2008. No consensus has been built on the upcoming quarter’s number reported on April 29, but with unemployment rising to 8.5%, factory orders rising a paltry 1.8%, consumer credit decreasing by $7.5B, and  retail sales ex auto rising less than 1% I’m less than optimistic. Industrial production has been no better. For the month of February, industrial production declined 1.4% compared to consensus estimates of 1.3% as manufacturing, mining, and utilities declined 0.7%, 0.4%, and 7.7% respectively. This was slightly better than January’s decline of 1.9%, but by no means to me a indication of a bottom. Capacity utilization rates have subsequently plummeted to 70.9%, no wonder unemployment is so high and weekly earnings have fallen, the demand just isn’t there.

Unemployment is another major monthly data point that has millions terrified of the prospects of the U. S economy. The unemployment rate has marched from 7.2% in December to 8.5% in March, and is likely to approach 10% in the coming months according to consensus. Nonfarm payrolls have dropped to  negative $633 thousand and the average workweek has remained flat just above 33 hours per week. This makes sense since changes in the workweek can be used to forecast changes in the workforce which can be an early indicator of a turnaround in the economy and in the business cycle.

Retail sales is another major indicator of the health of the economy that has failed to instill confidence, in my opinion, that the recession is nearing a bottom. As a brief recap of the importance of retail sales, consumer spending is the driving force of the American economy comprising of over 2/3 of GDP, nearly half of which is retail sales. Meanwhile personal income has contracted 0.2% as personal spending increased 0.2%. The difference in these two figures can be an early indicator of spending in the future, which currently doesn’t look strong given the steep decline in spending unmatched by an equally steep decline in income.  This indicates that consumers are becoming tight-fisted in this market, which is confirmed by the savings rate that has risen to 4.2% in February from less than 3% last October.

Indices to Consider

Now analysts such as those from the Credit Suisse Glencore Alliance have sighted the CRB Index as an indication that stabilization may have occurred.  The CRB Index has remained flat for the year. Meanwhile the Baltic Dry Index has risen over 150% since November lows, and has doubled during the course of 2009. I cannot deny that these are positive numbers, but I would like to see a global turnaround in the key data points I have mentioned above. In conclusion, I can understand why the mood has changed somewhat in regards to the slow down in the rate of decline, but as an investor who had his face ripped off last year I don’t think it’s quite time to commit major capital to many stocks in the sector. I would suggest holding off and waiting for the next big drop in the market before deciding to enter this sector.

Disclosure: The author is long FCX, MON and short DOW, IP, and DD.

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